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Definition

The market price of a share divided by its most recent average annual earnings per share. This gives the reciprocal of the "earnings yield", and is used by some investors to compare shares with other shares and other investment types. The PE ratio, also known as the "earnings multiple", is not much used in South Africa but is common overseas where the earnings yield is unknown. The P:E gives a good idea of the share's "rating". Highly-rated shares are those which have had steadily rising earnings for many years. Investors (especially institutional investors) are willing to pay much more for 100c of their earnings than for the same 100c in annual earnings from a company whose profits are erratic and unreliable. This means that their share price will be higher in relation to their profits. When a share has a high earnings multiple, we say that the earnings are of "good quality" - because they are likely to be repeated and increased in future years. A private company is usually worth between three and five times its after tax annual earnings. A listed company usually has a price:earnings ratio (P:E) of 10 or more - which makes it possible for a successful listed company to buy up private companies and realise an immediate gain when their earnings are revalued to the listed company's P:E. A good example of this is Hudaco's acquisition of Cadac for R100m announced in its results for the year to 30th November 2021. Cadac was bought for a maximum of R100m or 3 times its average after-tax annual earnings. Once part of the Hudaco group, Cadac's earnings were immediately revalued to Hudaco's P:E of 9,7. In other words, Cadac suddenly became worth R320m and the Hudaco shareholders made a gain of R220m (R320m - the R100m purchase price).

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